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Wednesday, April 18, 2012

Obama Needs His FDR Moment

Last year Christina Romer argued that Fed chairman Ben Bernanke needed a Volcker moment. What she meant is that like Paul Volcker in the early 1980s, Bernanke needs to rise to the occasion and adopt a new monetary regime radical enough to solve the big economic problem of the day. For Paul Volker the problem was ever increasing inflation and the new monetary regime was targeting bank reserves. For Ben Bernanke the problem is an ongoing aggregate demand slump and the new monetary regime would be nominal GDP (NGDP) level targeting. As someone who believes in NGDP level targeting, I too have been hoping the Ben Bernanke will have a Volcker moment. After all, it would not be too much of a stretch for him given his work on Japan. But he has not and therefore continues to keep Fed policy effectively tight as it has been since mid-2008. Fed vice-chairwoman Janet Yellen acknowledges as much. Tim Duy considers this to be maddening monetary policy, Karl Smith views it an utter policy failure, and Ryan Avent is banging his head in frustration over it.

Maybe it is time for us to admit that Bernanke will never have his Volcker moment. He has had many opportunities and whether because of groupthink at the Fed, political power of savers, or a failure by him to read Scott Sumner's blog, Bernanke cannot seem to find his Volcker moment. It is not clear he ever will. So instead of hoping Bernanke has a Volker moment, maybe we should be hoping for President Obama to have a FDR moment.

The FDR moment occurred in 1933 when FDR took the reigns of monetary policy from an ineffective Fed and sparked a robust recovery in aggregate demand. The Fed had allowed aggregate demand to collapse for three years when FDR responded. He signaled that he wanted the price level to return to its pre-crisis level (i.e. increased expectations of higher nominal spending) and acted upon it by having the Treasury Department devalue the gold content of the dollar. This dramatically increased the monetary base and spurred a sharp increase in aggregate demand.

So how could President Obama have his FDR moment? Like FDR, he should signal his intentions for higher level of nominal spending and follow through on it by having the Treasury Department take take the reigns of monetary policy from the Fed. President Obama could do this by announcing a NGDP level target that would be implemented by the Treasury Department creating large-denomination platinum coins that would be deposited at the Fed and used to fund checks to the public. The Treasury Department would keep making these coins until the the NGDP level target was hit. If NGDP went above the target the Treasury Department would issue bonds to withdraw the excess money.

Okay, that is a radical idea coming from me. It is a mongrel mix of Market Monetarism and Modern Monetary Realism. It is not my first choice of the Fed adopting a NGDP level target, but it should work. It makes use of expectations management which should minimize the number the actual number of platinum coins needed and if used as a threat it might even cause Bernanke to suddenly discover his Volcker moment.

19 comments:

Wouldn't it just be easier if the Obama administration pushed an NGDP target through Congress? I don't know how cooperative the Republicans would be, but it strikes me as more realistic than your idea, although interesting.

Or could it do something like that even without them -- like through a regulatory decision or executive order? (I doubt it, given the independence of the Fed, but I am not a lawyer.)

NGDP level targeting by the Fed is my first choice. So if Obama could push it through Congress then yes. Congress, however, has a number of hard-money advocates who would make it very difficult if not impossible to pass. Of course, what I am proposing would be seen as even more radical so it is not likely to happen either.

I'm all for this. Of course, you do understand that under the US system of government for the Treasury to "issue check", the spending needs to be authorized by Congress, right. Treasury can mint and cash the coin all by itself to get a big fat balance in the public Treasury. But only Congress can authorize the disbursement of funds from the Treasury.

“He should signal his intentions for higher level of nominal spending”

I may have misread this at first, but does it mean a higher desired level of NGDP, without necessarily requiring a higher deficit than already assumed? I now assume that’s the case, which seems consistent with a market monetarist approach.

Assuming that’s the case, and while it’s all highly hypothetical, some considerations for the gentleman in question:

If Obama announced an NGDP target, he owns the target. So he would need to be confident that he had sufficient control over the means to achieve the target.

Your proposal is equivalent to “front-end” QE – i.e. conversion of prospective debt financing to money financing, using the Beowulf/MMR coin idea as the balance sheet catalyst. Hypothetically, are you confident from a market monetarist perspective that this path alone would be sufficient for Obama’s political purposes to achieve the announced target?

I.e. would you see no need for him to have additional cover in the form of contingent supplementary back-end QE to help galvanize the MM NGDP target transmission effect? If so, wouldn’t "taking the reigns" involve Treasury taking full control of Fed operations? After all, the plan in the form you suggest already exerts substantial Treasury influence over the projected Fed balance sheet, other things equal. Moreover, the Fed already has contingent plans to withdraw the reserve impact of cumulative QE to date at some point, using such techniques as system reverses, term deposits, etc. So the announcement alone puts Bernanke out of a job, the way I see it.

And given his ownership of the target, would you see no need for him to have even further additional cover in the form of contingent fiscal expansion plans with assumed Congressional co-operation and authorization?

Without those things, leaves him pretty exposed, no?

Radical is one thing; politically stupid is another.

Unless he announces he’s a fully converted and born again market monetarist at the same time. Now that’s commitment.

Wait a minute. I am not an economist, but for the last few years I've been reading up on how the crisis happened, and its origins go back to the Volcker chairmanship. He didn't attack stagflation through reserves, he attacked it through draconian interest rates. At one point during his chairmanship I believe the overnight funds rate reached 20%. High teens, anyway. The real target of his policies was the labor union movement, and he handed Reagan a gift by crushing the unions, which made it easier for Reagan to annihilate PATCO (to this day we haven't recovered the safety levels we enjoyed before that). This is not an argument against NGDP level targeting, of course, but I think it's important to remember the past. In an essay called "The Rectification of Names," Confucius wrote, "If the correct words are not used, what is said is not what is meant, and the people will stand about in helpless confusion." I'm not persuaded NGDP level targeting would work, but a lot of economists whose opinions I've come to respect are in favor of it.

Yes the devil is in the details. This is why I would first go with the Fed doing a NGDP level target, though even then one could argue that Congress might get involved in such a radical change by the Fed.

Yes, I was thinking that the Treasury would send checks directly to households--essentially a helicopter drop. No further deficit is needed.

Regarding the plan's efficacy, I believe a big part of its success would come from the expectations it would create of higher nominal spending. A President promising to do a helicopter drop until the NGDP trend was hit should create a big shock to expectations that would automatically cause portfolios to rebalance and spending plans to change. Backing it up with successive platinum coin deposits at the Fed should be enough.

Yes, this would require Congressional support. But if President Obama had such support then he could trump any offsetting actions by the Fed. Hopefully the Fed would quickly adopt its own NGDP level target if the President just discussed the idea.

FDR's cover was the economic collapse of 1929-1933. He could try something so radical because of this collapse. Even though the economy is still in slump now, it is far better than it was in 1933. So it would be harder for Obama.

One way to do it. Create four trillion dollars in coinage and have the fed mark up the account of the social security trust fund. Go to congress and ask for legislation reducing the fica tax to no more than one percent of every paycheck. At least a five percent raise for workers, and five percent back for their employers. If congress can't get it done, it faces a difficult November. Give congress the right to destroy the coinage if they wish. Indicate to the fed that should they try to prematurely sterilize this move, that the general fund may need similar support.

The rhetoric employed to support this move is: "We bailed out the banks, bailed out the pension funds and the insurers, the unemployed and the state--now its time to help the guy making ten bucks an hour and the gal keeping him on the payroll."

"One way to do it. Create four trillion dollars in coinage and have the fed mark up the account of the social security trust fund. Go to congress and ask for legislation reducing the fica tax to no more than one percent of every paycheck. At least a five percent raise for workers, and five percent back for their employers."

This makes a lot of sense, its using coinage to fund a payroll tax holiday.